(Bloomberg) — Stocks hit all-time highs as bets that the Federal Reserve will soon start cutting interest rates fueled a rush in riskier corners of the market.
Most Read by Bloomberg
Wall Street extended a pattern of money swirling into small caps and out of megacap “safety” since last week’s soft inflation data. Over the past four sessions, the Russell 2000 has beaten the Nasdaq 100 by almost 12 percentage points — a feat not seen since 2011. An equal-weight version of the S&P 500 — where Nvidia Corp . have the same weight as Dollar Tree Inc. — exceeded the US equity benchmark. This index is less sensitive to earnings from larger companies – offering a glimpse of hope that the rally will widen.
“Rotation is the name of the game,” said Andrew Brenner at NatAlliance Securities. “This is consistent with the growing perception of rate cuts.”
Brenner pointed to the fact that around 4 a.m. New York time, Russell 2000 futures were up — while Nasdaq 100 contracts were down. “That means the overseas money, the big money, did a very large swing trade overnight,” he said.
For Solita Marcelli, at UBS Global Wealth Management, if the Federal Reserve can cut rates significantly in the context of a soft tapering, there will be better prospects for a re-acceleration of earnings growth for lower-quality segments and cyclical market. At Interactive Brokers, Jose Torres cited another possible reason for the rally in smaller firms: They tend to be country-oriented and are perceived to benefit “disproportionately” if Donald Trump wins the election.
The S&P 500 rose to 5,667 — its 38th record high this year. The Dow Jones Industrial Average rose 1.85%. The Russell 2000 gained 3.5%, marking its biggest five-day gain since 2020. The Nasdaq 100 was little changed. US 10-year yields fell seven basis points to 4.16%. Gold hit a record high.
Traders also went through profits. Bank of America Corp. provided a forecast for net interest income that exceeded expectations. Morgan Stanley traders joined the party across Wall Street in the second quarter, even as the firm’s largest wealth business missed expectations. Charles Schwab Corp. warned that it will have to shrink in order to protect profits.
While the expansion in U.S. stock growth is seen as a positive sign, small-cap growth in such a short period is showing signs of overheating. In just five days, the Russell 2000 is up almost 12% — hitting its most overbought level since 2017.
“History was made today as the Russell 2000 closed 4.4 standard deviations above the 50-DMA,” according to Bespoke Investment Group. “No other major US index (the Dow since 1900, the S&P 500 since 1928, and the Nasdaq since 1971) has ever closed at such an extreme.”
Matt Maley at Miller Tabak says the gauge has reached the kind of overbought condition that has been followed by declines over the past two years.
“So this could signal that the small-cap sector should have some sort of short-term breathing space,” he noted. “At the very least, investors should be cautious in pursuing these stocks in the short term.”
In such a case, he says it will be interesting to see if there is a reversal of the “rotation” movement. Tech stocks are emerging from their overbought state, so there’s no guarantee they’ll advance during a pullback in small-cap names, he said.
After all? If tech stocks and small caps fall at the same time, that could cause “some problems for the overall market,” he noted.
The move in the Russell 2000 is positive, but investors should be ready for a potential profit or consolidation in the coming sessions, according to Dan Wantrobski at Janney Montgomery Scott.
“The long-term monthly chart on the Russell shows a better picture of its potential,” he noted. “We believe the Russell 2000 could trade back toward its all-time highs as the mean reversion to relative strength highlights further bandwidth for the sector versus this year’s leadership (tech/AI/Mag7).
Wantrobski also noted that broader market breadth/participation has improved since the CPI rally last week.
“The battle between the broader markets and 2024 leadership is set to continue in the short term in our view, as the relative strength disparities between these groups indicate the potential for more rotation ahead,” Wantrobski said. “This cannot be confirmed as a long-term trend/investment theme at this time. So for now, we continue to treat this as a trading opportunity (moving average reversion).
Craig Johnson at Piper Sandler says it’s too early to tell if a stable rotation can be sustained. More time and technical evidence is needed to confirm the sustainable expansion of participation that can drive the market higher.
“The current (and long-awaited) expansion in capital gains is welcome, but elevated valuations will limit further market growth to the low single digits overall for the remainder of the year,” said Robert Teeter at Silvercrest Asset Management. .
For Lori Calvasina at RBC Capital Markets, earnings season will be a “key test” for swing trading. She added that the ratings and positioning have set the stage for an eventual shift to new leadership, but there have been some false starts.
The relative performance of the Nasdaq versus the Russell 2000 has been on a wild ride since 2020, with each beating the other by more than 40 percentage points during various one-year holding periods since the pandemic crisis, according to Nicholas Colas at DataTrek Research. Dramatic small-cap performance has only occurred after a tech stock crash or when retail investors created a small-cap bubble, he said.
“No setup is important right now. We believe the Nasdaq will outperform the Russell by its 2003-2019 average by two points over the next year,” he noted.
As for whether the S&P 500 or Russell 2000 will outperform over the rest of the year, his view is that both will now do equally well — but not at the same time because of their low correlation .
“Right now, small caps have the best momentum because money managers can’t afford to stay as underweight as they’ve been forced to be over the last 18 months,” Colas said. “Once their reweighting is done, S&P should be able to play catch-up.”
The S&P 500 has gone 351 sessions through Tuesday without a 2% decline. If the equity benchmark reaches 352 by Wednesday’s close, it will be the longest stretch since the start of the global financial crisis in 2007. The index went roughly 950 sessions from May 2003 to February 2007 without such a slide.
Stock market strength has been supported by optimism that the economy has weathered the worst of the Fed’s tightening. In that regard, Tuesday’s better-than-estimated retail sales report was a “healthy” development, according to Bret Kenwell at eToro. It’s better to see the Fed cut inflation rates down than to see the central bank rush to prop up a weakened economy, he noted.
The Dow Average also had an “extraordinary day” on hopes for rate cuts and lower taxes and regulations — which could be on the horizon, according to Chris Zaccarelli at the Independent Advisor Alliance. He also cited hopes that the market’s growth will expand from a narrow group of technology stocks to “a group of companies.”
Corporate highlights:
-
Goldman Sachs Group Inc. and Wells Fargo & Co . joined rival JPMorgan Chase & Co. on US investment-grade market gains following the second quarter earnings report.
-
PNC Financial Services Group Inc. marked its first increase in net interest income since the end of 2022, setting itself up for what it expects to be a record year of NII growth in 2025.
-
Microsoft Corp.’s investment. Inflection AI will face a full antitrust investigation in the UK after the watchdog said it needed to take a closer look at the AI startup’s hiring of former employees.
-
Philip Morris International Inc. is expanding production of Zyn in the US as the popular oral nicotine pouch becomes increasingly difficult to find due to increased demand.
-
Starboard Value became the third activist investor this year to take a stake in Match Group Inc., the owner of the dating app Tinder, whose paying customer base has shrunk for six straight quarters.
-
Adidas AG raised its annual profit target for the second time in three months, amid rising demand for classic sneakers like the Samba and more sales from shrinking stock of Yeezy shoes.
This week’s highlights:
-
Eurozone CPI, Wednesday
-
US housing starts, industrial production on Wednesday
-
Fed Beige Book, Wednesday
-
Fed Thomas Barkin of the Fed on Wednesday
-
ECB rate decision on Thursday
-
Initial US Jobless Claims, Philadelphia Fed Production, LEI Conference Board, Thursday
-
The Fed’s Mary Daly, Lorie Logan and Michelle Bowman speak Thursday
-
Fed John Williams, Raphael Bostic speak on Friday
Some of the main movements in the markets:
INVENTORY
-
The S&P 500 was up 0.6% as of 4 p.m. New York time
-
The Nasdaq 100 was little changed
-
The Dow Jones Industrial Average rose 1.85%
-
MSCI World Index rose 0.4%
-
Russell 2000 index rose 3.5%
currencies
-
The Bloomberg Dollar Spot Index is little changed
-
The euro is little changed at $1.0901
-
The British pound was little changed at $1.2974
-
The Japanese yen fell 0.2% to 158.39 per dollar
Cryptocurrencies
-
Bitcoin rose 2.2% to $65,153.51
-
Ether rose 1.1% to $3,474.43
BONDS
-
The 10-year Treasury yield fell seven basis points to 4.16%
-
Germany’s 10-year yield fell five basis points to 2.43%
-
Britain’s 10-year yield fell five basis points to 4.05%
wares
-
West Texas Intermediate crude fell 1.3% to $80.87 a barrel
-
Spot gold rose 1.9% to $2,468.56 an ounce
This story was produced with the help of Bloomberg Automation.
–With help from Lu Wang, Esha Dey, Jessica Menton and Sophie Caronello.
Most Read from Bloomberg Businessweek
©2024 Bloomberg LP